Consumer Credit: What Is Reverse Equity?

Information on reverse equity, and how it could affect you. An explanation of assets commonly affected.

Many people buy new vehicles and intend to trade in their existing vehicle in the process. However, have you ever heard of a salesperson say that your car has "reverse equity," then ask you for a bigger down payment? What exactly is reverse equity and how does it affect you? Following is an explanation.

Reverse Equity is an issue that affects many car owners. Especially those who have financed their car purchase. The technical meaning of this term is when you owe more on your loan balance than what the vehicle is actually worth. An automobile is one of several assets that depreciate in value very quickly. In fact, it has been said that a car loses its value as soon as you drive it off the dealership's lot. You will especially suffer from reverse equity if you intend to trade in your existing vehicle within the first couple of years of you car loan. This is due to the fact that in the beginning of any loan, the bulk of your payment is applied almost entirely to the interest and not the principle. Some car salesman will also refer to reverse equity as being "upside down" on your car's value. Once you find yourself in this predicament there isn't much you can do to get yourself out of this matter favorably. If you intend on trading in your car, and you find a dealership who will agree to the trade, they will apply the negative value of your car towards the new loan balance, thus putting you in a deeper hole. In effect, you will be signing a new car loan with reverse equity built into the new loan. So think wisely before doing so. You would be much better off paying off your existing car loan to a point where the value of your car is more than the loan balance, thus eliminating the reverse equity.

There were times in history where a homeowner would experience the same phenomenon. This occurred in the eighties, for instance, when the real estate market crashed. Home values dropped, and homeowners had outstanding mortgage amounts that were worth more than the value of the home. This made it very difficult for homeowners in those days to sell their homes without bringing thousands of dollars to the closing table. It was these times when terms such as "creative financing" and "seller financing" were born. Homeowners had to find creative ways to sell their homes. Otherwise they would literally be giving their homes away. Many homeowners would hold a mortgage and receive monthly payments from the buyers, thus creating a monthly cash flow. Today this is no longer the case as home prices have skyrocketed in recent years.

With all this said, how does one protect themselves from having reverse equity affect them? For starters, it helps if you are able to put a substantial down payment when you are purchasing something major such as a car or home. Also, whenever possible, add a little extra to your monthly payments towards your loan balance. Doing so will help reduce the principle balance on your loans, and help prevent reverse equity.